Fiscal dominance occurs when the fiscal policy of a government takes precedence over monetary policy, influencing the central bank's ability to manage inflation and interest rates. This scenario often arises in situations where high levels of government debt compel the central bank to accommodate fiscal needs, leading to potential conflicts between controlling inflation and supporting government financing. Understanding fiscal dominance is crucial for analyzing the dynamics of inflation and exchange rate management in various economies, especially in relation to how monetary authorities navigate these challenges.
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